The labor market is the centerpiece of every economy. It determines how society’s human resources are utilized, both over time and across individuals, and how much workers are compensated for their labor services. In all countries, the labor market is the largest market in the economy, with workers receiving roughly 60 percent or more of the total income that is generated by market production.
An equally important issue is how well the labor market functions. The difference between a poorly functioning labor market and a well-functioning labor market can mean millions of lost jobs and billions of dollars in lost incomes.
Government policies and institutions have important effects on the efficiency of the labor market. In some economies, such as the United States, labor markets are not heavily regulated, tax rates are fairly low, and economic freedom is relatively high. In some other countries, labor markets are heavily regulated, tax rates are high, and consequently there is less economic freedom.
This paper summarizes research on how government policies that affect freedom of choice within the labor market impact its performance and efficiency. These policies include taxation, minimum wages, unionization, and occupational licensing requirements.
This review shows that freer labor markets, which have lower tax rates, less regulation, and more competition, are much more efficient and dynamic and are associated with higher employee compensation and greater employment.
These findings have important implications for economic policy making. They indicate that policies that enhance the free and efficient operation of the labor market significantly expand opportunities and increase prosperity. Moreover, they suggest that economic policy reforms can substantially improve economic performance in countries with heavily regulated labor markets and high tax rates.
As the United States and the rest of the world continue to address the health, economic, and social challenges presented by the novel coronavirus, sound labor market policies that respect the principles of economic and personal freedom will be central for restoring economic growth, while at the same time promoting public safety.
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